Preventing runs under sequential revelation of liquidity needs

Abstract

I examine whether a financial intermediary issuing demandable debt can eliminate run equilibria by properly adjusting or restricting payouts in case of heavy redemptions. I study a model where investors learn their own liquidity needs over time and may withdraw preemptively before knowing their future liquidity needs. The difficulty in preventing runs is that, on the one hand, imposing temporary restrictions on withdrawals in case of excess redemptions may be necessary to avoid costly asset liquidations, while on the other hand, it is precisely the prospect of such restrictions on withdrawals that may induce investors to withdraw preemptively. Implementation of the first-best allocation without a run equilibrium is possible if and only if either liquidation costs are not too high or investors are not too risk averse.